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01 February 2013

Unemployment and Entrepreneurship

Risky Business | 4 Percent: " . . . Experts commonly invoke the “entrepreneurial eco-system” to explain how new businesses come into existence. The assumption is that localized environmental conditions make new businesses possible. But it may well be that much larger forces are responsible. Worrying about localities may be misplaced if the question is how to get more firms started in America. Even the content of the term “entrepreneurial eco-system” is hardly settled. It seems to suggest some features of a local economy (money, mentors, minds, and magic) that, when working together in some optimal way, produce more new businesses than might otherwise be expected. Since some places grow (e.g., Austin, Texas) and some contract (name any “rust belt” city), there is always an audience to hear why the former are more congenial to entrepreneurs. Michael Porter’s cluster theory, which holds that pre-existing conditions explain everything, is often invoked, as is Richard Florida’s notion of inducing more “creatives” to relocate by changing conditions such as “tolerance” and the inventory of loft housing. (The assumption, certainly open to question, is that people inclined to inventing new companies prefer such housing.) But it may be that place and other local ingredients seem important simply because they appear amenable to change. Porter’s and Florida’s theories actually might not have much to do with aggregate rates of new firm formation. Focusing on local characteristics and not on the macro forces influencing new firm creation is like looking at medicine rather than public health. In medicine, the patient in front of the doctor is the focal point; in public health, the whole population is of interest. Research initiated by the Kauffman Foundation in 2008 enables us to develop a “public-health” perspective on the nation’s entrepreneurial activity. At long last, a perspective on the nation’s entrepreneurial eco-system is beginning to emerge. . . . The data also permit us to speculate about a very important question: Why are fewer people starting new firms? Let me propose a link between new firms and the general level of economic activity. . . The entrepreneur, who could have taken a conventional job if he or she could have found one, knows that the difference between the normal 5% unemployment rate and the current nominal rate of 8% is more severe than just three percentage points. Indeed, from the entrepreneur’s perspective the chances of recovering from the risk of starting a company that fails is measured as some multiple of the current three percentage point difference between full employment (5%) and the current rate of 8%. Let us call this multiple the entrepreneur’s risk exposure index: It is the number that holds back entrepreneurs from taking the risk of starting a new company. . . ."